Anyone who has watched a renovation reality TV show knows that a run down real estate nightmare could be a cash cow in disguise. It seems simple enough. Buy a fixer-upper, spend a bit of money on cosmetic changes, style the property and sell it for a huge profit! Many savvy investors with the energy and money to dedicate to such an enterprise, as well as the design flair to pull it off, have done this successfully for years.
But there are some pitfalls, and if you’re not careful, you can also end up paying a lot of tax. In this article, I will talk about the practical considerations you need to make before taking on a house flipping project, as well as explain how the ATO looks at property renovations and what constitutes a business. There may be significant income tax and GST considerations that have not been taken into account in a keen renovator’s budget, which may tip the scale in favour of long-term investment.
While the renovation shows on TV make house flipping look like an overnight success, the truth is, renovating properties does take a considerable amount of physical work and mental stress. Some renovation projects can drag on for months or even years, go over budget, and be met with resistance from neighbours (particularly in strata schemes) which can land you in NCAT proceedings and council disputes. In the worst case scenario, you may even be required to reverse the renovation.
It is imperative that you have a business plan (whether you are in the business of property renovation, or just renovating your first property as a one-off project) before you even start looking for properties to buy.
In addition to all of the above, you then need to think about the tax consequences. The tax implications may significantly reduce your profit. Having the right entity structure from the start could potentially save you a lot of tax as well.
This refers to home owners who renovate their own home or investment property and sell it for a profit.
If the property was your primary place of residence (PPR), then any gain you make is exempt from Capital Gains tax (you can treat the property as your PPR for up to 4 years prior to moving in, under certain circumstances).
If the property was held for more than 12 months, the owner may be eligible to a 50% Capital Gains Tax (CGT) discount on any gains (depending on tax residency status). However, beware of knocking down investment properties and re-building, or significantly changing the structure (substantial renovations), as this could create a CGT event in itself and attract Goods & Services Tax (GST) on the sale.
This sort of renovation is not generally considered “Property Flipping”, but worth noting because of the potential tax savings.
Property Flipping is a term used to describe purchasing property and selling it quickly for profit. It usually involves renovating the property to add value, and a successful ‘flip’ will involve adding significantly higher value proportionate to the time and cost of the renovation.
ATO has 2 distinct categories for “property flipping”, but they are essentially treated the same way for tax purposes. The first is where you are conducting an activity for the purpose of making a profit, and the second is where you are running a renovation (or property development) business.
In both scenarios, the profit you make is treated as your income and must be reported in your tax return (or the return of whatever entity is conducting the business activity, e.g. a company or a trading trust).
Under this scenario, you will not be eligible for a CGT discount, even if the renovation took more than 12 months to complete. You cannot claim the profit against carried forward capital losses. You also will need to register for and pay GST on the sale value (you will be able to claim input tax on certain purchases, and may also be eligible for the margin scheme).
It is important to know the following before conducting any property flipping activity:
Whether you are taking on a one-off renovation project, or starting up a renovation business, it is important to speak to a tax professional to make sure that you are not going to end up with a huge unexpected GST and tax bill at the end of the day.